SUBPRIME BAILOUT

January 24, 2008

As with most economic problems, we find the hand of government in the subprime lending mess, says Walter E. Williams, a nationally syndicated economist and professor of economics at George Mason University.

Consider:

The Community Reinvestment Act of 1977 is a federal law that mandates lenders to offer credit throughout their entire market and discourages them from restricting their credit services to high-income markets, a practice known as redlining.

In other words, the Community Reinvestment Act encourages banks and thrifts to make loans to riskier customers.

Many lenders did make loans to people who had no realistic ability to repay them. But that doesn't qualify as fraud, though there might have been a bit of exuberance in the repackaging of the mortgages into securities and selling them to investors, says Williams.

To make matters worse, President Bush's plan to deal with the subprime crisis is to freeze interest rates on adjustable rate mortgages:

That is a gross violation of basic contract rights and would appear to be a Fifth Amendment violation.

If a contractual agreement is willingly entered into and agreed upon by a borrower and lender, it is binding and if broken by one party or the other, harsh penalties should ensue.

So, under the Bush plan, millions of contracts will be declared null and void, says Williams. The long-run effect of the Bush plan is to make lending institutions even more selective in choosing borrowers. Then there's the question: If government can invalidate the terms of one kind of contractual agreement where the borrowers can't pay, what's to say it won't invalidate other contractual agreements where the borrowers encounter hardship and what will that do to financial markets?